The Real Housewives of Wall Street

If you’re an American, this shouldn’t make you angry, it should make you incandescent with rage. As the Federal Reserve, for the first time in its history is forced to open its books following an act of Congress, some very dirty laundry is being uncovered. What did happen to all that bailout money?

Of course, if trillions of dollars of new money are created and handed out arbitrarily, it is likely that a few million will go astray. The beneficiaries are being made known to the US public, and not before time! Rolling Stone does a good job in explaining just how it easy it was to make millions of dollars, risk free, doing no work at all.

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It should be pointed out that Matt Taibbi is mostly in the business of scoring political points. He doesn’t mention the key role the Republican libertarian senator Ron Paul played in getting Congress to open the Fed’s books.

He ask “Why isn’t Wall Street in Jail”. He doesn’t mean simply criminals in Wall Street, he means everyone in the finance industry. He isn’t really differentiating between honestly earned wealth and dishonestly earned wealth though he may claim to do that. Rather he’s attacking the wealthy in general.

I get the impression when reading his articles that what he really wants to do to people like myself and the writers and readers of this site is to “pop a cap in our ass”.

However, some of the moral outrage that these folk feel may make them receptive to the libertarian ideas if only they were exposed to them. An awful lot of ideologically-driven free marketeers were at one point socialists.

Current may be right in pointing to Taibbi’s political views, but Taibbi nevertheless asks a perfectly valid question, as follows. If the Fed is going to hand out trillions of newly printed dollars in a recession (which I’m in favour of in principle) why did the money go to proven incompetents and crooks on Wall Street rather than to Main Street? The inventor, Thomas Edison, asked the same question in the following quote from the New York Times, 6th Dec, 1921.

“If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good… If the Government issues bonds, the brokers will sell them. The bonds will be negotiable; they will be considered as gilt edged paper. Why? Because the government is behind them, but who is behind the Government? The people. Therefore it is the people who constitute the basis of Government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest bearing currency… instead of the bankers receiving the benefit of the people’s credit in interest-bearing bonds?”

A state can eliminate banking from involvement in monetary policy, money creation and money destruction. In my view this isn’t really wise though.

As I’ve said before, I support a regime of free banking where financial institutions create their own moneys and money-substitutes. We don’t have anything like that now. In the situation we’re in now where there is no appetite for institutional reform I support central banking targeting a long-run NGDP trend. That’s my “2nd best” (or maybe 3rd best) choice.

Anyway, suppose we have an MMT regime where banks are 100% reserved. Money is fiat money and when the monetary authority decide it’s appropriate the government create money “from thin air”. Then, when that authority believes that it’s appropriate the government increase taxes and destroys the money it has collected in rather than spending it.

What this effectively means is that fiduciary media are abolished and that part of banking is folded into the government’s fiat currency.

The problem with such a regime is that it’s really a great deal more political than the one we have now. Let’s say we’re at “monetary equilibrium” and the long-run price level trend is ~0%. That is, there is no demand for a greater quantity of money than currently exists. In that case, despite what some MMT advocates say taxation would be necessary. The government may create money, but in order to maintain price stability and remain at monetary equilibrium it must tax correspondingly. If the government just create money then they will cause injection effects, then price inflation and thereby the economy will leave monetary equilibrium.

Now, let’s say that the demand for money rises sharply, as in a recession like this one. In this case the government can create money and spend it. But, the spending decisions taken here will be political. Then, later on, when a demand for money falls the government must raise taxes to prevent price inflation. In this case the same political considerations apply, the tax rises are unlikely to be non-political.

Consider this simple example. Suppose there is an excess demand for £100 billion of new money. Let’s say we have the type of classical central banking system and the reserve ratio is 10%. In that case the central bank will create new reserves and lend them out until there is £100 billion extra in current account balances. With a 10% reserve ratio this may take more than £10 billion of new reserves. But in most cases it’s unlikely to be much more because banks have a strong financial incentive not to hold excess reserves. Then once the excess demand passes and is replaced by an excess supply the central bank can destroy the reserves it created. In this situation the central bank can charge the commercial banks for reserves and take payment in debt.

Now consider the “direct” option. In this case the government must create £100 billion in fiat money and spend it. Then later they must tax back a similar amount.

It’s certainly true that banking licences are political. Businesses with connections get them. But, in the classical central banking case this means that at worst the *reserves* are sold to commercial banks for less than their value. Inevitably this happens and it enriches commercial bankers, I’ll admit that. But, in the “direct” case things are much worse, the *whole sum* is subject to political decisions. There is no real assurance that it will be spent in the interest of “main street”.

The bailouts of the past few years are if anything an argument for the old principles and against the direct concept. TARP and the other bailout plans are debt-deals certainly, but they are more targeted than classical open-market operations. In pre-2008 central banking the central banks would increase the monetary base by purchasing homogeneous government assets such as bonds. That benefited all holders of those assets similarly. After the targeted bailouts the Bernanke Fed instigated this changed to targeted purchases of non-government assets. This isn’t handing money out, but on a spectrum it is closer to handing money out than OMOs. And this handout benefited the well-connected as the Rolling Stone article mentions. There is little reason to suppose that an even more direct handout wouldn’t do the same. Certainly it would help if a more representative government agency than the Fed were doing the money creation, but it wouldn’t solve the problem.

In my view the targeting was a major reason that the recession lasted so long. In banking crises the worst banks must fail. Propping them up by lending cheaply to them isn’t very productive because those businesses have too much inner-turmoil to deal with to be able to lend out effectively. A better policy is to lend out only against good collateral to solvent banks. That means solvent banks thrive and insolvent ones go bankrupt quickly. This would have been preferable to what happened. In my opinion the amount of new reserves needed to satisfy the demand for money this way would have been much less than the amount that were created.

If there is excess demand for money, I would expect the price of money (interest rates) to rise (in the absence of central bank manipulation).

The interest rate isn’t the price of a holding of money, it’s the price of borrowing. The closest things there is to a “price of money” is the overall price level.

Mises writes about this on p.402-404 of “Human Action”. Borrowing is one specific way to obtain a stock of money by agreeing to pay another person for it in the future according to a repayment scheme. But, that’s only one of many ways to obtain money. If you think about it, any sale of assets, goods or services for money with the aim of keeping the proceeds is “demanding money”. In austrian economics when we talk about demanding money we mean the same microeconomic things that we mean in the case of any other demand. If I go to a trader and offer money for potatoes then I’m demanding potatoes. Similarly, if I sell potatoes for money then I’m demanding money, at least at that very moment. I may intend to pass on that money directly afterwards, in which case I’m demanding a holding of money.

Changes in interest rates can’t satisfy the demand for money overall because they can’t increase the stock of money. Consider a town with 10 cars for rent. There are only 10 cars and the stock can’t be increased. In this case rental rates can’t increase the quantity of cars. If the demand for cars increases then the rental cost of cars increases but that doesn’t mean the demand is satisfied. Exactly because the demand isn’t satisfied the value of those 10 cars will increase. The same thing is true for money. If the demand for money holdings rises then the interest rate can rise (it won’t necessarily). But that doesn’t clear the excess demand, that can only happen by a rise in the value of money – that is by price deflation.

@MRG
I think it’s misleading to think of interest rates as the price of money – they’re really the price of future money in relation to present money, i.e. the price of *time*.
The whole reason we need to take monetary theory seriously is because money does not have a market of it’s own. There is no “price” of money.

Also, if the government did feel the need to manipulate the money supply (to prevent deflation), why go through the banks? Why not just send every individual taxpayer a cheque for their portion of the new money, and let them spend it (or invest it) however they see fit.

There would still be winners and losers in this process, but it doesn’t seem quite as unfair and corrupt as funnelling the new money through the banks.

Of course, in a 100%-reserve system, I can’t see why deflation would ever be bad. It would only proceed at the rate of technological progress. The catastrophic deflation that most economists currently fear wouldn’t be possible, would it?

Also, if the government did feel the need to manipulate the money supply (to prevent deflation), why go through the banks? Why not just send every individual taxpayer a cheque for their portion of the new money, and let them spend it (or invest it) however they see fit.

I thought I just explained why in my reply to Ralph Musgrave.

To clarify, there is no need in this situation for wealth redistribution. Handing people a cheque may satisfy a demand for money, but it also gives those who receive it wealth at the cost of others.

When I talk about the demand for money, or the demand for anything else I mean that in the strictly economic sense. A “demand” is an offer to to supply something in exchange for something else. It’s not a desire. The points on a demand schedule represent the quantity that would be demanded at different prices. So, if the price of a sack of potatoes is £4 then the demand will be for X potatoes, and if it’s £5 then it would be for Y potatoes where X > Y. It means that in the first case £4 * X would be handed over by customers and in the second £5 * Y. The same is true of money, only if someone offers a good, service or asset (a financial asset will do such as an agreement to pay back a loan) do they demand money in the economic sense of the word. Demand for money can be satisfied by creation of money and sale of it for a price.

Keynesians and MMTers such as Ralph Musgrave wish to tack on redistribution. But this comes with all of the pitfalls of any other process of redistribution. It causes a deadweight loss to those who are taxed to pay for it who then have a lessened incentive to work or otherwise create output. It causes that loss whether the taxation is direct or by long-term erosion of the purchasing power of money by price inflation. And of course it discourages those who benefit from working as hard as they would have done.

There would still be winners and losers in this process, but it doesn’t seem quite as unfair and corrupt as funnelling the new money through the banks.

No, it’s much worse, see the explanation I gave to Ralph above. In a central banking system in the worst case the reserves are given away for political ends. In most practical cases only a difference between two interest rates is handed over to the well-connected. In the MMT system where the state create new money the entire value of the quantity of money created is allocated politically.

Of course, in a 100%-reserve system, I can’t see why deflation would ever be bad. It would only proceed at the rate of technological progress. The catastrophic deflation that most economists currently fear wouldn’t be possible, would it?

In a 100% reserve system in the long term deflation would proceed with the rate of productivity improvement, yes. However, in the short term prices would fluctuate with the demand for money holdings. So, if the demand for money holdings rose by 10% then prices must fall by 10%, and inevitably output will fall in that process. Severe deflation and severe inflation are both possible.

My guess is that this sort of scam has not gone on in the UK to the same sort of extent. The reason for my thinking this is the following:
a) The bank of England produces an annual report and is audited. Hence, it is not shrouded in as much secrecy as the Fed.
b) There are fewer but much larger banks in the UK than the US. The US has literally thousands of banks. This is partly why, the US’s solution to the crisis was to grant money with guarantees to buy up a bunch of dodgy assets. By contrast, the UK’s solution was simply to nationalise most of its banks. There was no specific scheme like TALF or TARP passed in the UK as there was in the US.

However, while it is unlikely that individuals benefitted in quite the same way, the bigger picture is that in the UK, as in the US, the banks have been big beneficiaries of the Bank of England asset purchase schemes. If it weren’t for these schemes, all banks would have gone bust. As it is, banks have taken the money, continued to operate and are still able to pay out their employees large bonuses. This has debased your money, so that the cost of goods has gone up relative to where it would have been. In this way, wealth has been transferred away from the populace towards the employees of the banks.